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Quadratic Capital Management’s Nancy Davis said the next “big short” is betting against volatility.
“I think the challenge has been that we’re in a very, very low-yield, low-return environment,” said Davis, Quadratic’s managing partner and chief investment officer. “So investors have been forced to figure other ways of generating yield in their portfolio, and I think a very common theme — and I think it’s the best sharp trade out there — has been selling volatility.”
“I like to say the big short out there is people who are short vol,” she added.
Wall Street’s fear gauge posted its lowest close ever Thursday as U.S. stock markets continued to mark record highs.
The CBOE Volatility Index, or VIX, hit 9.19 Thursday but traded higher at 9.63 Friday. This widely followed index reflects the bets of options traders on the direction of the S&P 500. As measured by short interest in the iPath S&P 500 VIX Short-Term Futures exchange-traded note (VXX), bets against stock market swings remain near their highest on record.
Quadratic Capital is based in Greenwich, Connecticut, and is majority owned by women. The advisory firm primarily uses derivatives to invest in its global macro strategies.
iPath S&P 500 Vix Short-Term Futures Short Interest five-year chart
Source: FactSet
That said, well-known investors like DoubleLine’s Jeff Gundlach this summer predicted a spike in volatility later in the year.
He said that in his firm’s analysis, volatility is so low that it can make a big return, and he positioned for that by buying put options — bets for a decline — on the S&P 500 for December. “It’s not really a bear call on the S&P 500. It’s more of a bull call on volatility,” he said.
Davis was speaking at the Sohn conference, a West Coast version of the investment conferences that began in New York and are best known for hedge-fund managers making market-moving presentations. The Sohn conferences benefit pediatric cancer and other causes for underserved youth. The conference is presented in partnership with CNBC.
At the conference, Davis recommended investors bet against two business development companies whose debt holdings make them particularly vulnerable to rising interest rates.
“The Fed reducing the balance sheet is a major game changer,” said Davis during her presentation. “The first place that’s going to feel that is the levered credit market.”
